Monday, 14 January 2013

The platinum coin controversy

The hottest economic topic in the first days of 2013 - or at least, in America - undoubtedly has to be the fiscal cliff and it's aftereffects. And while the terms like fiscal cliff, debt consolidation and austerity might sound like yet another round of obscure financial gibberish, one of the solutions proposed as the solution of America's mounting public finance crisis is certainly more interesting. How could a 1,000,000,000,000 dollar platinum coin be the solution? And what is the problem in the first place?

Add 10 zeros. Source: Wikimedia

Origins of the problem

Readers of this blog may already be familiar with our description and thought experiment with the fiscal cliff - the topping on the USA's public debt cake. The USA has long been spending more than it can account for in tax incomes - hence, public debt levels have been steadily rising ever since the 1980's, as illustrated by this graph below.

The situation was made worse by the Bush era tax cuts (see first link), which further increased the government deficit and hence, debt. These were supposed to expire on December 31st 2012 (likely causing a recession, since nobody likes sudden tax increases), but in the last minute the Democrats and Republicans dodged it by making the compromise of only letting the cuts expire for the rich.

Whoa, stop there, you might say - why is high government debt even relevant for the economy?
Well, high government debt is bad news for investors - a government constantly increasing their debt is less likely to pay back your loan (that is, the yields of your bond purchase), and is bad news for the economy; as presented in the post linked above and here, it decreases real GDP growth. And meanwhile, even though the cliff was mutilated down to a slope, the debt threat still remains. The latest round of debates concern the 'debt ceiling', the largest amount of debt the USA can legally own - if it goes above that, the USA is (rudely) forced to declare default.

Origins of the solution

So imagine you're running a household; you spend more than you earn, and you have to fix the situation before the tax collectors break the door on you (the microeconomic equivalent of a state bankruptcy). What do you do? You naturally will try to increase your income (e.g. by taking a second job, or working extra shifts) and decrease your spending (e.g. by going out less). This is naturally not the lifestyle you're used to, and you'll likely feel miserable until you're back in the black.

Now imagine that the same thing happens with the USA. In this case, feeling miserable would mean hundreds of thousands of lost jobs, voters angered by tax increases, recessions - so things any politician would like to avoid. This is why Democrats and Republicans can't reach a compromise on the matter (as of late, to raise the debt ceiling, a fancy way of budget cosmetics) - but luckily for them, someone has invented the coin.

The platinum coin controversy

The fundamental difference between the household budget and the USA government budget (besides that the USA is way richer than you) is that the USA uses a currency which they can create. Just imagine: printing your own dollars (pounds, forints, etc) to cover all those drinks in your favorite clubs! Naturally, after a time club owners would notice and they would start rejecting your money.
This is no different on the government scale; when the amount of money grows more rapidly than the amount of goods it accounts for, the value of money deteriorates - this is called inflation. To avoid this kind of "money printing", decisionmakers have separated the institution which creates the money (the central bank) and the institution which spends it (here, the government). Or at least, almost - and this is where the coin comes in.

Disclaimer: this is actually a very basic approximation of public finance. For a less clumsy explanation, read our post series on the issue here, here, here and here.

The coin magic...

Compared to the introduction above, the "coin magic" is quite simple. The US Treasury retained the power of issuing coins in whatever number and denomination it pleases; traditionally, to issue memorial coins and such. However, this also presents a recently discovered loophole; the power to mint ANY coin it pleases. In this case, we're talking about a 1,000,000,000,000 dollar-value platinum coin; the Treasury does it, the Federal Reserve (central bank) buys it, and the USA state budget is better off with 1 trillion dollars.

...and why magic doesn't work

Now what is the problem with his proposition? If economists such as Nobel prize winner Paul Krugman endorse it, I really shouldn't be the one to contradict, should I? The problem is that it doesn't solve anything; it's just a cosmetic cover-up of the underlying debt problem.
Think about it this way: If you earn 500$ a week, but spend 1000$, you'll have a weekly deficit of 500$. Imagine that a friend gives you 10,000$ to get you back on your feet. If you continue to spend that money the way you used to, without restructuring your budget, then in the end you'll still be bankrupt - and the friend's money gone to waste; in the government's case, 1 trillion dollars gone to waste, fueling inflation.
Naturally, the extending of the debt ceiling is no better - but creating platinum coins whenever we feel like it would be a violation of the sensible, predictable public finance policy we'd all like to see - just as Lars Christensen points out on Market Monetarist.

Final calculation

Finally, let's conduct a thought experiment; if the ratio of the coin's thickness and diameter is 1:13 (based on the Hungarian 50 Ft coin, a fairly large one), then what dimensions would our 1,000,000,000,000$ coin require if we'd like the platinum inside it to be actually worth 1 trillion?

The mass of such a coin would be given by the following equation:

M = ρ * R2 * π * (1/13) * R, where

M is mass, ρ is density, and R is the radius of the coin we're creating.
Given the fact that the price of platinum is $53,209.49 per kg, 1 trillion dollars would be the equivalent of 1,000,000,000,000/ 53,209.49 =  18793640 kg of platinum. Since platinum's density on room temperature is 21450 kg/m3, the volume this much platinum would fullfill is 18793640 / 21450 = 876,16 m3. This, divided by 1/13π gives us R3, which is 3625,57 m; from here, R equals 15,36 m; the diameter of the resulting coin being 30,72 m, as large as the Christ the Redeemer statue in Rio De Janeiro (without the piedestal).

The USA Treasury certainly has some interesting tools in it's hand.

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